Cheesecake Factory Profitability Analysis: 5-Year

Cheesecake Factory Profitability Analysis: 5-Year projection for cash flow / risk rate

Cheesecake Factory Profitability Analysis

The current project focuses on the analysis of the Cheesecake Factory from various angles, including its internal characteristics, the features of the industry and markets in which it operates, its financial highlights and ratios, as well as its ability to control external features. The scope of all these analyses was represented by the ultimate ability to conduct five-year projections for the cash flows and the net income, in order to create a price to be paid for the Cheesecake Factory. In other words, the scope of the current endeavor is that of evaluating the company and forming a final recommendation as to whether or not the firm should be purchased. The aim of the prospective purchase is that of combining resources and products to create diversity and increase profits and returns on equity. Based on the analysis conducted, it was concluded that the Cheesecake Factory would be a profitable investment to make. Specifically, it was found that the company does encounter several challenges, such as lower sales levels, but these issues are generically pegged to external pressures. At an internal level, the company reveals impressive strengths that would help it overcome the threats. The Cheesecake Factory is then worth investing in as it would retrieve higher levels of profitability in the future.

2. Company description

The Cheesecake Factory was founded in 1971 in Los Angeles, California, and it opened its first restaurant seven years later, in Beverly Hills, California. The Cheesecake Factory operates over 150 restaurants in the United States, as well as other restaurants, operated under different brands -- the Grand Lux Cafe and the RockSugar Pan Asian Kitchen.

The restaurants of the Cheesecake Factory are present in 35 American states and the menus include over 200 items. The business success of the Cheesecake Factory has been based on the intense diversification of the menu -- which includes foods from sandwiches to stakes --, the integration of products specific to the restaurants -- the most important of them being the cheesecakes which are served in about 40 different ways -- as well as the creation of large portions of foods. Also, an element which creates points of difference in comparison to other restaurants is the fact that the foods served by the Cheesecake Factory can be combined and customized in order to offer the best value for the customers.

Another point of difference revealed by the Cheesecake Factory is represented by the design of the stores. For all restaurants, the company has created glamour and glitz, inspired from the casinos in Las Vegas. This design enhances the customer experience and adds more value to the clients. Aside from these, the Cheesecake Factory has also opened bakery factories, in which it produces desserts that are then sold in grocery stores (Hoovers, 2011). Diversity is as such present not only in the menu, but also in the business operations.

Aside from the United States however, the Cheesecake Factory also strives to open and operate stores in other global regions. At the beginning of 2011, this desire came closer to materialization as the managerial team at the Cheesecake Factory entered into an exclusive agreement with the Alshaya Group in Kuwait. The scope of the agreement is that of opening and operating 22 new Cheesecake Factory restaurants in five states of the Middle East: Kuwait, the United Arab Emirates, Bahrain, Qatar and the Kingdom of Saudi Arabia. This agreement represents not only an opportunity to sell the company's products onto the selected five Middle East markets, but also the ability to use these new markets as door openers to other regions. In other words, the experience in the five states of the Middle East could serve as opportunity to create the know-how essential for a wider international expansion. Within the future, the Cheesecake Factory also wants to expand its operations in North Africa, Central and Eastern Europe, Russia and Turkey (Reimer, 2011).

3. Economy and industry prospects

The general state of the economy in the United States is poor, with the crisis having revealed severe shortages in the national fiscal system. The information received from authority sources is conflicting, with some arguing that the crisis has been overcome, whereas others arguing that the American economy is closer to collapse than it has ever been. Currently, the United States Congress is focused on finding new financial sources without creating fiscal pressure, and preventing the government from going into payment incapacity.

In this state of the economy, the population and the business community face severe challenges. Economic agents have a restricted access to funds, as the banks and other financial institutions are being extremely prudential and have restricted the access to loans. With lower profits and demands, business agents are forced to reduce their operations, downsize or even declare bankrupt. In such a context, people lose their jobs and, subsequently, their ability to repay their loans. Their purchasing powers are diminished and this impacts all consumer industries.

Overall then, the state of the economy is unstable and the future is difficult to foresee. Nevertheless, this situation is expected to change as the recession would be overcome and the national output would increase. While in 2009, the economy contracted by 0.4 per cent, during the period from 2012 through 2014, it is expected for it to increase by an annual average of 4.4 per cent. For the year 2011, the projection is that of a 2.4 increase in the real gross domestic product. After 2015 however, the growth rate of the GDP is expected to decrease as the economy overcomes the crisis and becomes more and more stable. The table below indicates these projections:

Table 1: Economic projections 2010 -- 2020

Estimate for 2009

Forecast for 2010

Forecast for 2011

Projected annual average for 2012-2014

Projected annual average for 2015-2020

Real GDP

GDP price index

Consumer price index

Nominal GDP

$14,253 billion

$14,706 billion

15,166 billion

$17,816 billion

$22,770 billion

Nominal GDP, percentage change

Unemployment rate

10.1%

Interest rate, three-month treasury bill rate

Interest rate, ten-year treasury note rate

Source: Congressional Budget Office, 2010

4. Financial highlights

At a general level, the financial competence of the Cheesecake Factory remains increased and this is obvious in terms of its stable revenues. Within the current economic climate, in which numerous economic agents were forced to declare bankrupt, the Cheesecake Factory has generated positive revenues. The table below reveals the financial highlights of the Cheesecake Factory from 2006 through 2010 (data available in the company's last Annual Report).

Table 2: Financial highlights for the Cheesecake Factory

2010

2009

2008

2007

2006

Revenues

$1,659.4 million

$1,602.0 million

$1,606.4 million

$1,511.6 million

$1,315.3 million

Comparable restaurant sales

Operating income margin

Diluted income per share

$1.42

$1.07

$0.84

$1.01

$1.02

Cash flow from operations

$165.2 million

$197.1 million

$169.2 million

$160.1 million

$152.7 million

Restaurants open at the beginning of the fiscal year

Source: The Cheesecake Factory 2010 Annual Report

As it can be observed from the highlights above, the company has followed a generally ascendant trend with the exceptions of 2009 and 2010, when specific decreases were registered. In 2010 for instance, the economic agent registered a $4.4 million decrease in its sales revenues, but recovered in 2010 with a $57.4 million increase in sales revenues. However, in 2010, the Cheesecake Factory registered a $31.9 million decrease in its cash flows, which had, until that time, followed an ascendant path. These decreases in cash flows and sales revenues reveal the fact that the Cheesecake Factory was not immune to the internationalized financial crisis and that the decreasing purchasing power of its consumers also took its tool on the firm. Nevertheless, the stability of the financial highlights from the past years and the already recovering sales indicate that the firm possesses the ability to create future profits.

5. Valuation analysis

The company's revenues and earnings per share have been following an ascendant trend throughout the past years, as is revealed in the table below:

Table 3: Revenues and earnings per share in 2009, 2010 and 2011 (as measured in June)

2009

2010

2011

Revenues

$407.944 million

$418.909 million

$430.746 million

Earnings per share

$0.27583

$0.31594

$0.42236

Source: Reuters, 2011

The sustained increase in the overall company income and earnings per share indicate the strong financial position of the organization, which has managed to succeed even in times of economic challenges. Since 2009, the EPS has almost doubled, indicating as such a greater value creation for the shareholders. Also, the increase in the earnings per share indicates that the company has become more profitable in time.

Aside from the revenues and the evolution of the earnings per share, the company's condition is also revealed with the aid of other ratios, such as the return on equity, the return on assets, the gross profit margin or the debt to equity ratio. The table below reveals the values of these ratios for the Cheesecake Factory in 2011 as well as the five years averages. For comparison purposes, it also integrates the industry averages. This tripe presentation of the ratios allows for the comparison of the company's evaluation relative to itself, as well as its current comparison relative to the other players in the restaurants' industry.

Table 4: Financial ratios

2011

5-year average

Industry average

Price to earnings ratio

20.77

21.52

35.11

Sales

3.63

7.02

9.97

Debt to equity ratio

0.0

0.19

78.34

Gross profit margin

74.71

74.81

57.78

Net profit margin

5.28

4.28

1.49

Return on equity

NA*

11.7

10.22

Return on assets

8.3

6.1

6.15

Return on invested capital

14.7

7.52

7.38

* The return on equity cannot be collected as the company has not made public the total shareholder equity for 2010, with the last data in the annual report only revealing the equity for 2009.

* Data collected from Reuters and Forbes

Interpretation of the financial ratios:

The price to earnings ratio indicates values lower than the industry averages, revealing as such decreased investor expectations regarding future gains. Nevertheless, it is noted that the P/E ratio has increased when compared to its past values at the Cheesecake Factory, to as such indicate an increasing financial strength and enhancing possibilities for the shares to become even more profitable in the future.

The sales ratio is an indicator of organizational growth and the current values reveal decreasing consumer interest in the products of the Cheesecake Factory relative to the past years, as well as relative to the other players in the industry.

The debt to equity ratio is a rate of financial strength, which, in this case, indicates a decreased level of the organizational strength. Still, it is noted that the values hereby assumed are inconclusive as insufficient data is made available by the firm.

The gross and net profit margins have evolved at low rates compared to the past recent years, but they are significantly higher than the industry averages. It as such means that the company is able to retain more money from its sales than most players in the restaurants industry.

The returns on assets and investment capitals are only slightly different from the returns of the previous years; nevertheless, they are significantly higher than the average returns in the industry. This specifically means that the Cheesecake Factory is better able to generate money from its assets and is better able to make profitable investments that generate positive returns.

6. Future strength and position

The valuation analysis of the Cheesecake Factory has revealed both positive as well as negative aspects of the organization. Nevertheless, it is now estimated that the negative dimensions of the ratio analysis would be overcome and that they are linked to forces in the external environment. Additionally, the internal environment has revealed increased strength and the ability to capitalize on its strong points and transform them into gains. It is expected that the future would witness a growingly stronger organization, generating higher sales, more profits and occupying a more competitive position within the industry. The market share of the Cheesecake Factory is also expected to increase, especially as it ventures into new markets. In other words, it is believed that the company would come to perform at levels higher than the industry averages and from this standpoint, a recommendation is made to purchase the Cheesecake Factory, as this would generate a positive return on investment.

7. Control of external forces

As it has been mentioned throughout the previous stages of the analysis, the Cheesecake Factory relies on a strong internal structure, due to which it maintains high levels of profitability and positive returns on its investments. Nevertheless, it continues to be challenged by forces in the external environment, such as the reduced purchasing powers of the customers, the intensity of the competition, the bargaining power of the unions or the changing consumer demands and consumption trends. To all these issues, the Cheesecake Factory has to respond through processes of development and adaptation. In terms of the economic crisis which reduces purchasing powers, a solution is represented by the expansion so that wider markets can be accessed, combined with the further diversification of the menu in order to ensure that buyers have a greater access to the company's products.

Another important challenge of the external environment is represented by the changing consumer demands. In this order of ides, the Cheesecake Factory is renowned for its highly rich and tasty foods, but which contain high quantities of sugar, calories and carbohydrates. This means that an unhealthy dimension is added to the foods. This dimension is worrying in a context in which more and more diseases of the twenty first century are pegged to inadequate nutrition. In such a context then, consumers across the world come to place an increased emphasis on a healthier nutrition, which is not currently the focus of the Cheesecake Factory. Similar to other external challenges, the company can overcome this threat by readjusting its business model to fit emergent demands and features in the environment. The past successes and the current position indicate the company's ability to withstand and overcome external challenges.

8. 5-year projections of cash flows and net incomes

8.1. Net income projection

2006

2007

2008

2009

2010

Net income

$81,282,000.00

$73,964,000.00

$52,293,000.00

$42,833,000.00

$81,713,000.00

Annual growth

-9.003223346

-29.29938889

-18.09037538

90.77113441

Average growth 2006-2010

8.594536696

2010

2011

2012

2013

2014

2015

Projected growth

$81,713,000

$88,732,147

$96,354,238

$104,631,067

$113,618,876

$123,378,737

The net income projection was based on the net income for years 2006-2010, as shown in the company's annual report. For each year (except for 2006, since there is no data for 2005, the annual growth for that year was calculating as Net Income for current year minus Net Income for previous year, divided by the Net Income for previous year. The result was multiplied by 100 to have a percentage result of this evaluation. With these results, an average net income growth was calculated as an arithmetic average of the four values of annual growth. The result was 8.59%, which was used as the basis of the net income projection for the next five years.

There are several important notes and comments to be made with relation to this income projection. First, one needs to point towards the trend of the net income figures at the Cheesecake Factory. Starting at a certain level in 2006 (level which was only equaled in 2010), the net income at the company has gradually decreased over the next years, with as much as -29% in 2008.

Looking over the Income Statement, it appears that this decrease is explained not necessarily through a problem on the revenues side of the organization (these have gradually and constantly grown over the 2006-2010 period), but rather because of higher costs of sales during the years of decreasing net income. It is difficult to understand whether this has occurred because of the economic crisis or because of organizational problems within the company. However, while the projection rate that was used is an average of the yearly increases or decreases, it is important to note that the fluctuations from year to year during the analyzed period were often significant.